Week in Review

Money is a temporary storage of value. We created money to make trade easier. We once bartered. We looked for people to trade with. But trying to find someone with something you wanted (say, a bottle of wine) that wanted what you had (say olive oil) could take a lot of time. Time that could be better spent making wine or olive oil. So the longer it took to search to find someone to trade with the more it cost in lost wine and olive oil production. Which is why we call this looking for people to trade goods with ‘search costs’.

Money changed that. Winemakers could sell their wine for money. And take that money to the supermarket and buy olive oil. And the olive oil maker could do likewise. Greatly increasing the efficiency of the market. There is a very important point here. Money facilitated trade between people who created value. Creating something of value is key. Because if people were just given money without producing anything of value they couldn’t trade that money for anything. For if people didn’t create things of value to buy what good was that money?

Today, thanks to Keynesian economics, governments everywhere believe they can create economic activity with money. And use their monetary powers to try and manipulate things in the economy to favor them. And one of their favorite things to do is to devalue their money. Make it worth less. So governments that borrow a lot of money can repay that money later with devalued money. Money that is worth less. So they are in effect paying back less than they borrowed. And governments love doing that. Of course, people who loan money are none too keen with this. Because they are getting less back than they loaned out originally. And there is another reason why governments love to devalue their money. Especially if they have a large export economy.

Before anyone can buy from another country they have to exchange their money first. And the more money they get in exchange the more they can buy from the exporting country. This is the same reason why you can enjoy a five-star vacation in a tropical resort in some foreign country for about $25. I’m exaggerating here but the point is that if you vacation in a country with a very devalued currency your money will buy a lot there. But the problem with making your exports cheap by devaluing your currency is that it has a down side. For a country to buy imports they, too, first have to exchange their currency. And when they exchange it for a much stronger currency it takes a lot more of it to buy those imports. Which is why when you devalue your currency you raise prices. Because it takes more of a devalued currency to buy things that a stronger currency can buy. Something the good people in Japan are currently experiencing under Abenomics (see Japan Risks Public Souring on Abenomics as Prices Surge by Toru Fujioka and Masahiro Hidaka posted 4/14/2014 on Bloomberg).

Prime Minister Shinzo Abe’s bid to vault Japan out of 15 years of deflation risks losing public support by spurring too much inflation too quickly as companies add extra price increases to this month’s sales-tax bump.

Businesses from Suntory Beverage and Food Ltd. to beef bowl chain Yoshinoya Holdings Co. have raised costs more than the 3 percentage point levy increase. This month’s inflation rate could be 3.5 percent, the fastest since 1982, according to Yoshiki Shinke, the most accurate forecaster of Japan’s economy for two years running in data compiled by Bloomberg…

“Households are already seeing their real incomes eroding and it will get worse with faster inflation,” said Taro Saito, director of economic research at NLI Research Institute, who says he’s seen prices of Chinese food and coffee rising more than the sales levy. “Consumer spending will weaken and a rebound in the economy will lack strength, putting Abe in a difficult position…”

Abe’s attack on deflation — spearheaded by unprecedented easing by the central bank — has helped weaken the yen by 23 percent against the dollar over the past year and a half, boosting the cost of imported goods and energy for Japanese companies.

Japan is an island nation with few raw materials. They have to import a lot. Including much of their energy. Especially since shutting down their nuclear reactors. Japan has a lot of manufacturing. But that manufacturing needs raw materials. And energy. Which are more costly with a devalued yen. Increasing their costs. Which they, of course, have to pay for when they sell their products. So their higher costs increase the prices their customers pay. Leaving the people of Japan with less money to buy their other household goods that are also rising in price. Which is why economies with high rates of inflation go into recession. As the recession will correct those high prices. With, of course, deflation.

Keynesians all think they can manipulate the market place to their favor by playing with monetary policy. But they are losing sight of a fundamental concept in a free market economy. Money doesn’t have value. It only holds value temporarily. It’s the things the factories produce that have value. And whenever you make it more difficult (i.e., raise their costs by devaluing the currency) for them to create value they will create less value. And the economy as a whole will suffer.